Grand Canyon FIn450 module 3-8 assignment

Module 4


 - P14-3
 - P14-7
 - P14-10
 - P14-17

Problem 14-3



Residual dividend policy As president of Young’s of
California, a large clothing

 

 



chain, you have just received a letter from a major
stockholder. The stockholder

 

 



asks about the company’s dividend policy. In fact, the
stockholder has asked you to

 

 



estimate the amount of the dividend that you are likely to
pay next year. You have

 

 



not yet collected all the information about the expected
dividend payment, but you

 

 



do know the following:

 

 

 

 

 

 

 





 

 

 

 

 

 

 



(1) The company follows a residual dividend policy.

 

 

 

 

 



(2) The total capital budget for next year is likely to be
one of three amounts,

 

 



depending on the results of capital budgeting studies that
are currently under

 

 



way. The capital expenditure amounts are $2 million, $3
million, and

 

 

 



$4 million.

 

 

 

 

 

 

 



(3) The forecasted level of potential retained earnings next
year is $2 million.

 

 



(4) The target or optimal capital structure is a debt ratio
of 40%.

 

 

 

 



You have decided to respond by sending the stockholder the
best information available

 



to you.

 

 

 

 

 

 

 





 

 

 

 

 

 

 



a. Describe a residual dividend policy.

 

 

 

 

 

 



b. Compute the amount of the dividend (or the amount of new
common stock

 

 



needed) and the dividend payout ratio for each of the three
capital expenditure

 

 



amounts.

 

 

 

 

 

 

 



 

 

 

 

 

 

 



 

 

 

 

 

 

 



c. Compare, contrast, and discuss the amount of dividends
(calculated in part b)

 

 



associated with each of the three capital expenditure
amounts.

 

 

 

 



 

 

 

 

 

 

 



Problem 14-7



P14–7 Alternative dividend policies Over the last 10 years,
a firm has had the earnings per



share shown in the following table.

 

 

 

 



 

 

 

 

 



Year

 



Earnings per share

 



Year

 



Earnings per share

 

 



2015

 



$ 4.00

 



2010

 



$ 2.40

 

 



2014

 



$ 3.80

 



2009

 



$ 1.20

 

 



2013

 



$ 3.20

 



2008

 



$ 1.80

 

 



2012

 



$ 2.80

 



2007

 



$ (0.50)

 

 



2011

 



$ 3.20

 



2006

 



$ 0.25

 

 



 

 

 

 

 



a. If the firm’s dividend policy were based on a constant
payout ratio of 40% for

 



all years with positive earnings and 0% otherwise, what
would be the annual

 



dividend for each year?

 

 

 

 





 

 

 

 



b. If the firm had a dividend payout of $1.00 per share,
increasing by $0.10 per



share whenever the dividend payout fell below 50% for two
consecutive years,



what annual dividend would the firm pay each year?

 



 

 

 

 



 





 

 

 

 



c. If the firm’s policy were to pay $0.50 per share each
period except when earnings



per share exceed $3.00, when an extra dividend equal to 80%
of earnings beyond



$3.00 would be paid, what annual dividend would the firm pay
each year?

 



 

 

 

 



 

 

 

 



d. Discuss the pros and cons of each dividend policy
described in parts a through c.



 

 

 

 



Problem 14-10



Cash versus stock dividend Milwaukee Tool has the following
stockholders’ equity



account. The firm’s common stock currently sells for $4 per
share.



Preferred stock

 

 



$ 1,00,000.00



Common stock (400,000 shares at $1 par)

 



$ 4,00,000.00



Paid-in capital in excess of par

 

 



$ 2,00,000.00



Retained earnings

 

 



$ 3,20,000.00



Total stockholders’ equity

 

 



$ 10,20,000.00



 

 



a. Show the effects on the firm of a cash dividend of $0.01,
$0.05, $0.10, and



$0.20 per share.

 

 



b. Show the effects on the firm of a 1%, 5%, 10%, and 20%
stock dividend.

 

 



 

 

 

 



 

 

 

 



c. Compare the effects in parts a and b. What are the
significant differences between

 

 



the two methods of paying dividends?

 

 

 



Problem 14-17



Stock repurchase The following financial data on the Bond
Recording Company are

 



available:

 

 

 

 

 

 



Earnings available for common stockholders

 

 



$ 8,00,000.00

 

 



Number of shares of common stock outstanding

 

 



4,00,000

 

 



Earnings per share ($800,000 / 400,000)

 

 

 



$ 2.00

 

 



Market price per share

 

 

 

 



$ 20.00

 

 



Price/earnings (P/E) ratio ($20 / $2)

 

 

 



10

 

 





 

 

 

 

 

 



The firm is currently considering whether it should use
$400,000 of its earnings to

 



pay cash dividends of $1 per share or to repurchase stock at
$21 per share.

 

 





 

 

 

 

 

 



a. Approximately how many shares of stock can the firm
repurchase at the $21-pershare

 



price, using the funds that would have gone to pay the cash
dividend?

 

 



b. Calculate the EPS after the repurchase. Explain your
calculations.

 

 



 

 

 

 

 

 



c. If the stock still sells at 10 times earnings, what will
the market price be after the

 



repurchase?

 

 

 

 

 

 



 

 

 

 

 

 



 

 

 

 

 

 



d. Compare the pre- and postrepurchase earnings per share.

 

 



 

 

 

 

 

 



 

 

 

 

 

 



e. Compare and contrast the stockholders’ positions under
the dividend and repurchase

 



alternatives. What are the tax implications under each
alternative?

 

 



Module 5


 - P15-3
 - P15-9
 - P15-12
 - P15-16
 - P16-6
 - P16-13
 - P16-15
 - P16-20

Multiple changes in cash conversion cycle Garrett Industries turns
over its inventory

six times each year; it has an average collection period of 45
days and an average 

payment period of 30 days. The firm’s annual sales are $3 million.
Assume that 

there is no difference in the investment per dollar of sales in
inventory, receivables,

and payables, and assume a 365-day year. 
a. Calculate the firm’s cash conversion cycle, its daily cash
operating expenditure, 

and the amount of resources needed to support its cash conversion
cycle. 

 

 

b. Find the firm’s cash conversion cycle and resource investment
requirement if it 

makes the following changes simultaneously. 

(1) Shortens the average age of inventory by 5 days. 

(2) Speeds the collection of accounts receivable by an average of
10 days. 

(3) Extends the average payment period by 10 days. 

c. If the firm pays 13% for its resource investment, by how much,
if anything, 

could it increase its annual profit as a result of the changes in
part b? 

 

d. If the annual cost of achieving the profit in part c is
$35,000, what action would 

you recommend to the firm? Why? 





Problem 15-9

Accounts receivable changes with bad debts A firm is evaluating an
accounts receivable 

change that would increase bad debts from 2% to 4% of sales. Sales
are currently 

50,000 units, the selling price is $20 per unit, and the variable
cost per unit is 

$15. As a result of the proposed change, sales are forecast to
increase to 60,000 units. 

 

a. What are bad debts in dollars currently and under the proposed
change? 

 

b. Calculate the cost of the marginal bad debts to the firm. 

 

c. Ignoring the additional profit contribution from increased
sales, if the proposed 

change saves $3,500 and causes no change in the average investment
in accounts 

receivable, would you recommend it? Explain. 

d. Considering all changes in costs and benefits, would you
recommend the proposed 

change? Explain. 

 

e. Compare and discuss your answers in parts c and d. 





Problem 15-12



Shortening the credit period A firm is contemplating shortening
its credit period 

from 40 to 30 days and believes that, as a result of this change,
its average collection

period will decline from 45 to 36 days. Bad-debt expenses are
expected to decrease

from 1.5% to 1% of sales. The firm is currently selling 12,000
units but believes 

that sales will decline to 10,000 units as a result of the
proposed change. The sale 

price per unit is $56, and the variable cost per unit is $45. The
firm has a required 

return on equal-risk investments of 25%. Evaluate this decision,
and make a recommendation

to the firm. (Note: Assume a 365-day year.) 



Problem 15-16



Zero-balance account Union Company is considering establishment of
a zero-balance

account. The firm currently maintains an average balance of
$420,000 in its 

disbursement account. As compensation to the bank for maintaining
the zero-balance

account, the firm will have to pay a monthly fee of $1,000 and
maintain a $300,000 

non–interest-earning deposit in the bank. The firm currently has
no other deposits in

the bank. Evaluate the proposed zero-balance account, and make a
recommendation

to the firm, assuming that it has a 12% opportunity cost. 



Problem 16-6



Cash discount decisions Prairie Manufacturing has four possible
suppliers, all of 

which offer different credit terms. Except for the differences in
credit terms, their

products and services are virtually identical. The credit terms
offered by these suppliers

are shown in the following table. (Note: Assume a 365-day year.) 

 

Supplier Credit
terms 

J 1/5 net 30 EOM 

K 2/20 net 80 EOM 

L 1/15 net 60
EOM 

M 3/10 net 90 EOM 

 

a. Calculate the approximate cost of giving up the cash discount
from each supplier.

c. Now assume that the firm could stretch by 30 days its accounts
payable (net

period only) from supplier M. What impact, if any, would that have
on your

answer in part b relative to this supplier? 



Problem 16-13





Compensating balance versus discount loan Weathers Catering
Supply, Inc., needs

to borrow $150,000 for 6 months. State Bank has offered to lend
the funds at a 9%

annual rate subject to a 10% compensating balance. (Note: Weathers
currently

maintains $0 on deposit in State Bank.) Frost Finance Co. has
offered to lend the

funds at a 9% annual rate with discount-loan terms. The principal
of both loans

would be payable at maturity as a single sum. 

 

a. Calculate the effective annual rate of interest on each loan. 

 

 

b. What could Weathers do that would reduce the effective annual
rate on the State

Bank loan? 



Problem 16-15



Cost of commercial paper Commercial paper is usually sold at a
discount. Fan

Corporation has just sold an issue of 90-day commercial paper with
a face value of

$1 million. The firm has received initial proceeds of $978,000.
(Note: Assume a

365-day year.) 

 

a. What effective annual rate will the firm pay for financing with
commercial paper,

assuming that it is rolled over every 90 days throughout the year?

b. If a brokerage fee of $9,612 was paid from the initial proceeds
to an investment

banker for selling the issue, what effective annual rate will the
firm pay, assuming

that the paper is rolled over every 90 days throughout the year?





Problem 16-20



Inventory financing Raymond Manufacturing faces a liquidity
crisis: It needs a loan

of $100,000 for 1 month. Having no source of additional unsecured
borrowing, the

firm must find a secured short-term lender. The firm’s accounts
receivable are quite

low, but its inventory is considered liquid and reasonably good
collateral. The book

value of the inventory is $300,000, of which $120,000 is finished
goods. (Note: Assume

a 365-day year.) 

(1) City-Wide Bank will make a $100,000 trust receipt loan against
the finished 

goods inventory. The annual interest rate on the loan is 12% on
the outstanding

loan balance plus a 0.25% administration fee levied against the
$100,000 initial 

loan amount. Because it will be liquidated as inventory is sold,
the average 

amount owed over the month is expected to be $75,000. 

(2) Sun State Bank will lend $100,000 against a floating lien on
the book value of

inventory for the 1-month period at an annual interest rate of
13%. 

(3) Citizens’ Bank and Trust will lend $100,000 against a
warehouse receipt on the

finished goods inventory and charge 15% annual interest on the
outstanding 

loan balance. A 0.5% warehousing fee will be levied against the
average amount

borrowed. Because the loan will be liquidated as inventory is
sold, the average

loan balance is expected to be $60,000. 

 

a. Calculate the dollar cost of each of the proposed plans for
obtaining an initial

loan amount of $100,000. 

b. Which plan do you recommend? Why? 

 

c. If the firm had made a purchase of $100,000 for which it had
been given terms 

of 2/10 net 30, would it increase the firm’s profitability to give
up the discount 

and not borrow as recommended in part b? Why or why not? 



Module 6


 - P17-4
 - P17-6
 - P17-8
 - P17-14
 - P17-19
 - P17-21

The firm will pay $1,800 per year for a service contract that
covers all

maintenance costs; insurance and other costs will be borne by the
firm. The firm

plans to keep the equipment and use it beyond its 3-year recovery
period.

 

a. Calculate the after-tax cash outflows associated with each
alternative.

b. Calculate the present value of each cash outflow stream, using
the after-tax cost

of debt. 

c. Which alternative—lease or purchase—would you recommend? Why?



Problem 17-6



Lease-versus-purchase decision Joanna Browne is considering either
leasing or 

purchasing a new Chrysler Sebring convertible that has a
manufacturer’s suggested 

retail price (MSRP) of $33,000. The dealership offers a 3-year
lease that requires a 

capital payment of $3,300 ($3,000 down payment 1 $300 security
deposit) and 

monthly payments of $494. Purchasing requires a $2,640 down
payment, sales tax 

of 6.5% ($2,145), and 36 monthly payments of $784. Joanna
estimates that the 

value of the car will be $17,000 at the end of 3 years. She can
earn 5% annual interest 

on her savings and is subject to a 6.5% sales tax on purchases. 

Make a reasonable recommendation to Joanna using a
lease-versus-purchase 

analysis that, for simplicity, ignores the time value of money. 

 

Calculate the total cost of leasing. 

b. Calculate the total cost of purchasing.

c. Which should Joanna do?





Problem 17-8

Conversion price Calculate the conversion price for each of the
following 

convertible bonds: 

 

a. A $1,000-par-value bond that is convertible into 20 shares of
common stock. 

 

b. A $500-par-value bond that is convertible into 25 shares of
common stock. 

 

A $1,000-par-value bond that is convertible into 50 shares of
common stock. 

Problem 17-14





Determining values: Convertible bond Craig’s Cake Company has an
outstanding 

issue of 15-year convertible bonds with a $1,000 par value. These
bonds are convertible 

into 80 shares of common stock. They have a 13% annual coupon
interest 

rate, whereas the interest rate on straight bonds of similar risk
is 16%. 

 

Calculate the straight bond value of this bond. 

b. Calculate the conversion (or stock) value of the bond when the
market price is

$9, $12, $13, $15, and $20 per share of common stock.

c. For each of the common stock prices given in part b, at what
price would you expect the bond to sell?
Why? 

 

 

 

 

d. Make a graph of the straight value and conversion value of the
bond for each common stock price given. Plot the per-share common stock prices
on the x axis and the bond values on
the y axis. Use this graph to indicate the minimum market value of the bond
associated with each common stock price. 





Problem 17-19



Common stock versus warrant investment Tom Baldwin can invest
$6,300 in the 

common stock or the warrants of Lexington Life Insurance. The
common stock is 

currently selling for $30 per share. Its warrants, which provide
for the purchase of 

two shares of common stock at $28 per share, are currently selling
for $7. The stock 

is expected to rise to a market price of $32 within the next year,
so the expected theoretical 

value of a warrant over the next year is $8. The expiration date
of the warrant 

is 1 year from the present. 

 

 

a. If Mr. Baldwin purchases the stock, holds it for 1 year, and
then sells it for $32, 

what is his total gain? (Ignore brokerage fees and taxes.) 

 

b. If Mr. Baldwin purchases the warrants and converts them to
common stock in 

1 year, what is his total gain if the market price of common
shares is actually 

$32? (Ignore brokerage fees and taxes.) 

 

 

c. Repeat parts a and b, assuming that the market price of the
stock in 1 year is 

(1) $30 and (2) $28. 



d. Discuss the two alternatives and the trade-offs associated with
them. 



Problem 17-21





Call option Carol Krebs is considering buying 100 shares of Sooner
Products, Inc., 

at $62 per share. Because she has read that the firm will probably
soon receive certain 

large orders from abroad, she expects the price of Sooner to
increase to $70 per 

share. As an alternative, Carol is considering purchase of a call
option for 100 

shares of Sooner at a strike price of $60. The 90-day option will
cost $600. Ignore 

any brokerage fees or dividends. 

 

 

a. What will Carol’s profit be on the stock transaction if its
price does rise to $70 

and she sells? 

 

 

 

b. How much will Carol earn on the option transaction if the
underlying stock price 

rises to $70? 

 

 

 

c. How high must the stock price rise for Carol to break even on
the option transaction? 

 

d. Compare, contrast, and discuss the relative profit and risk
associated with the 

stock and the option transactions. 

 


Module 7


 - P18-3
 - P18-11
 - P18-12
 - P18-14

Module 8


 - P19-1
 - P19-3
 - P19-5